In times of turmoil, some investors like to have a bit of gold in their portfolios. One company that can provide it is Royal Gold, Inc. (RGLD, Financial).
Royal Gold is a gold streamer that described itself thus in its 10-K for 2020:
"A metal stream is a purchase agreement that provides, in exchange for an upfront deposit payment, the right to purchase all or a portion of one or more metals produced from a mine, at a price determined for the life of the transaction by the purchase agreement."
Buying the rights to a stream of production is an alternative to mining gold. It avoids the many operational issues involved in discovering, developing and mining the precious metal. Stream interests currently involve six producing and two developmental mining projects. They accounted for 72% of total revenue for the company in fiscal 2019 and fiscal 2020.
The company also participates in the royalties business:
Royalties are non-operating interests in mining projects that provide the right to a percentage of revenue or metals produced from the project after deducting specified costs, if any. As of June 30, 2020, we owned royalty interests on 35 producing properties, 14 development stage properties and 130 exploration stage properties, of which we consider 49 to be evaluation stage projects."
Royalties accounted for 28% of the company's total revenues in both 2019 and 2020. In the 10-K, Royal outlined a recent royalty agreement:
- It reached a deal with "various private individuals" to acquire a net smelter return royalty in a Chilean mine owned by a subsidiary of Barrick Gold Corporation (GOLD, Financial).
- The terms stipulate that Royal Gold will pay a total consideration of up to $41 million; of that amount, $11 million was paid in January 2020. Another $20 million is based on a coming project construction decision by Barrick and the size of the mineral deposit when that decision is made. A final $10 million will be paid when production begins.
- In exchange, Royal receives royalties of up to 1.06% on the gold and up to 1.59% on copper produced when the mine goes into operation.
The company's fortunes are largely tied to the price of gold, and less tangibly to the prices of silver and copper. Its financial state also is affected by the volume of production.
Royal became a publicly-traded company in 1981; since the early 2000s, investors who bought and held have enjoyed capital gains growth:
Financial strength
It has also produced healthy financial statements for years. The cash-to-debt ratio is greater than 1, meaning the company has enough cash, cash equivalents and marketable securities to pay all its debts. Similarly, we see the interest coverage ratio is high at more than 20. This shows us that Royal generated enough operating income to pay its interest expenses 20 times over in the quarter ended June 30.
Royal earns a higher return on invested capital (ROIC) than it pays in the weighted average cost of capital (WACC), indicating a value-creating company.
Profitability
Royal shines on the margins front, as both the operating margin and the net margin are high. Over the past decade, the operating margin has come down slightly, while the net margin has recovered from several dips:
Return on equity and return on assets are both industry-leading. Royal's ROE is higher than nearly 90% of the 2,041 companies in the Metals & Mining industry. ROA performance is even better as it is higher than 95% of its peers and competitors.
On the three growth lines at the bottom of the table, we see revenue growth has not been outstanding, but is still positive, as is its Ebitda growth. Most importantly for investors, the three-year average growth rate for earnings per share without non-recurring items is robust at 25%.
Valuation
The GuruFocus Value chart finds Royal is fairly valued. That lines up with what we see on the one-year price chart; the current price is down roughly $17 since it last peaked:
The price-earnings ratio looks high at 38.93, but it's well below the 10-year median of 57.28. Similarly, it is lower than about 75% of other companies in the industry.
The PEG ratio, which relates the price-earnings ratio to a company's Ebitda growth rate, shows the stock as overvalued. For PEG, 1.0 is the dividing line between undervalued and overvalued; at a PEG of 2.84, the stock seems overvalued.
Dividend and share buybacks
This gold streamer does pay a dividend, but it would be treated as something of an afterthought by investors. The dividend is below 1%, and even when we factor in the dividend growth rate, the five-year yield-on-cost only rises to 1.2%. That's negligible for many investors.
Investors have not gained from share repurchases; in fact, we see a negative buyback ratio, meaning the company is issuing shares rather than buying them back.
Gurus
Overall, the gurus who have traded the stock in the past year have been more bullish than bearish:
Seven gurus held positions in Royal at the end of the second quarter. The three largest of them were:
- First Eagle Investment (Trades, Portfolio), which reduced its holding by 5.6% to end the most recent quarter with 2,852,446 shares, good for a 4.35% interest in Royal
- Jim Simons (Trades, Portfolio) of Renaissance Technologies, who made a significant commitment by adding almost 43% to his holding to finish the quarter with 950,842 shares
- Pioneer Investments (Trades, Portfolio), which added 8.55% to end the quarter with 249,296 shares.
Conclusion
Not everyone likes gold or gold stocks, but for those who do, I think Royal Gold might be considered for their shortlists. It offers good financial strength and profitability. In particular, its margins are very good.
The share price is reasonable. While the price-earnings ratio is high, it is not so high when we put it in a historical context. Nevertheless, we must remember this stock will rise and fall with the price of gold (and to some extent, the prices of silver and copper). To put it another way, if economic conditions stabilize, Royal may be a less attractive stock.
This stock may suit growth investors who expect the price of gold to move up in the coming quarters and years. Value investors will not see enough margin of safety for their comfort. Income investors will look to other stocks with higher dividend yields or stocks with higher dividend growth rates.
Disclosure: I do not own shares in any of the companies named in this article.
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